Macro-Finance Outlook February 2016
The following graphic summarizes the Spring 2016 classes’ analysis of the lagging, coincident and leading indicators. Business activity was neutral for most of 2015 (lagging), and after accelerating briefly late in the year (coincident), economic activity is predicted to slump back into a slow-growth phase for most of 2016, with GDP struggling to grow at a real rate of 2%. The detailed analysis of each indicator follows below.
LA-1. The average Prime Rate is a benchmark rate that is used by lenders for determining the interest rate to use on new loans. Typically, this metric is seen as a lagging indicator as banks will adjust their rates in response to economic conditions. If the economic growth is slow, banks will have low rates to attract new borrowers. In contrast, if economic growth is strong, and has been for a while, banks can raise the rates. As in the case for pre-2001 and pre-2008 recessions, the interest rate rises and plateaus just before the recession and declines sharply after the recession is realized. Currently we see very low (some would say artificially low) interest rates and high corresponding amounts of commercial and industrial loans. At the end of 2015, we did the first rise in interest which would signal economic strength. For that reason, we give it a score of +1.
LA-2. The ratio of consumer credit to personal income measures the balance between the income and debt levels of consumers. Because individuals tend to borrow when they expect favorable economic conditions, this metric serves as a way of measuring consumer confidence in the economy. Typically, consumer credit is used to purchase long-lived goods. Based on some of the coincident and leading indicators, it seems that credit is instead being used to purchase more short-lived goods such as retail. Under normal circumstances, consumer credit is seen as a sign of confidence in future economic conditions but because credit is being used to purchase short-live goods we will assign a score of 0.
LA-3. The Consumer Price Index (CPI) for services measures inflation that occurs in the service sector. The CPI in the past 5 years has maintained a low and stable rate of inflation as compared to the past 30 years. Looking at the years after each of the last three recessions, we see that that it takes serval months and in some cases over a year for the inflation to drop significantly. After each recession we see a distinct trough followed by a gradual rise in inflation before the next recession takes place. Until the indicator hits its trough, there is little reason to expect unfavorable economic conditions. Also, while a low CPI is good for consumers, it is bad for businesses. In particular it hinders the ability of businesses to raises prices. Although the CPI has yet to hit its trough, its historically low rate signals that the expansion may not have much room to run. For these reasons, we assign a score of 0.
LA-4: The Inventory to Sales Ratio measures the amount of inventory held as a percentage of sales. The long term downward trend of this indicator is reflective of increasing efficiency in inventory management. In the 2001 and 2008-2009 recessions, inventory to sales peaked in the midst of the recession due to reduced retail spending; the ratio began to fall after the economy started to recover. From 2010 to 2014, the inventory to sales ratio remained fairly steady between 1.27 and 1.33 percent. Over 2015, the ratio increased quite dramatically to 1.38. In order for inventory to sales to indicate strong economic conditions, we should expect to see this ratio return to its 2005-2014 range of 1.25-1.30. The increase in inventory to sales over the past year indicates slowed economic growth, warranting a score of -1.
LA-5: The Total Consumer Credit and Commercial and Industrial Loans inidcator shows total outstanding credit to consumers and businesses. This measure is generally reflective of consumer and business confidence, and tends to increase during times of economic growth and decrease during recessions. During the 2008-2009 recession, it can be seen that the total amount of credit peaked and began to fall, for both consumers and businesses, during the middle of the recession. Credit has steadily grown since late 2010. This continued trend indicates that the economy has been steadily growing following the most recent recession. However, much of this credit growth can be attributed to the FED’s policy of zero interest rates, rendering this indicator unreliable as a measure of confidence. It receives a score of 0.
LA-6: Unit Labor Costs measure both nominal and real levels of labor cost per worker in the economy. Unit labor costs tend to peak midway through a recession, followed by a decline or sideways trend which continues well into an expansion. Nominal labor costs peaked just before the 2001 recession, falling dramatically during the recession, and trending sideways until 2004. It again peaked toward the end of 2008, falling until it began to recover in 2011. In real terms, labor costs have fallen dramatically since 2001, suggesting that labor costs have not kept up with the inflation rate. The lack of positive direction in real unit labor costs is the reason that this indicator receives a score of 0.
LA-7: The average duration of unemployment measures the average length of time it takes a laid off worker to find work, when analyzed alongside the labor force participation rate, it provides insight in to the recent employment outlook in the economy. Average duration of unemployment tends to rise dramatically during a recession, peaking a few months after the recession has ended – as it did in both of the recent recessions. Average duration of unemployment has continued its steady decline since its peak in 2010 to 10.7 weeks, though it has not returned to its pre-recession level. The continued decline in the labor force participation rate casts further doubt on the level of economic expansion. In a period of economic growth, we should expect to see labor force participation to increase toward its pre-recession rate, while average duration of unemployment should continue to decrease. These indicators show little economic growth and receive a score of 0.
CO-1: Total Sales This indicator measures the total retail sales including the food industry. When total sales are rising consumers and businesses feel more confident about current economic activity. This indicator has only been tracked through the last two recessions. During the 2001 recession, the indicator did not coincide with the recession due to a large increase in the consumer credit ratio. In 2008 the indicator begins trending steeply downward following the recession. The indicator begins trending upward slightly before the economy recovers from the recession. As the indicator continues trending upward into 2016, a noticeable gap is being created between ‘Total Sales’ and ‘Real Total Sales’, indicating a rise in inflation. The strong upward trend of this coincident indicator is a bullish signal and thus deserves a score of +1 on the diffusion index.
CO-2: Total Nonfarm Payrolls This indicator measures the total number of people with jobs in the U.S, whether full-time, part-time, or temporary. Historically this has been a reliable coincident indicator, as it rises with economic expansions and falls during economic contractions. When this indicator is rising it is associated as a bullish indicator to investors. Since the recovery of the recession in 2010, the indicator has been aggressively trending upward and has reached an all-time high. The steep incline in nonfarm payrolls indicates a strong economy and a bullish market, thus this coincident indicator deserves a +1 on the diffusion index.
CO-3: Income Less Transfers Personal income is the main source of consumer spending an is thus an effective measurement of growth. This indicator is based on personal income from individuals and excludes any form of transfer payments. Historically the indicator has leveled off during recessions, except during the 2008 recession where it began to trend downward months after the recession began. After the drop during the 2008 recession the indicator began to slowly trend back upward, turning into a sharp incline after 2010. A sharp spike can observed at the end of 2012, but then quickly fades into the beginning of 2013. The indicator is currently trending upward and achieving all-time highs, which makes it appropriate to issue a score of +1 for the diffusion index.
CO-4: Industrial Production This indicator measures physical output at all stages of production in the manufacturing, mining, and gas and electric utility industries. This index has been observed to have a strong correlation with changes in total output. The index appears to be more of a leading indicator as it trends steeply downward months before the 2001 crash. However in the recession of 2008 the indicator coincides with the recession. A large gap begins to form between ‘Industrial Production’ and ‘Real Industrial Production’ from 2009 to 2016. It can be assumed from this that inflation has been sharply increasing since 2009. Although production is trending upward, it fails to grow as quickly as it has in the past and begins to trend downward in the middle of 2015. Taking into factor the slow growth of output and the recent, small trend downward this indicator is given a score of 0 on the diffusion index.
LE1. Average Length Manufacturing and Construction Workweek. This leading indicator represents if manufactures in the U.S. need employees to work longer hours, if manufactures have new orders, and if the economy is increasing. Since after recovering from the ’08-’09 recession, manufacturing workweek has been trending relatively sideways, increasing only an hour, which indicates stability in the sector and overall economy. Manufacturing has experienced a slight contraction since November of 2014, if this continues, there is potential for the overall economic activity to decelerate, which may follow with higher unemployment rates. Construction workweek appears to be bouncing around in a state of consolidation since November of 2012. The indicator was given a rating of +1.
LE2. ISM New Manufacturing Orders Index. The ISM New Orders Index indicates if manufacturing orders are increasing or decreasing. 50 is considered the median for this index, any value greater represents new orders are increasing, thus any value under 50 represents that the number of new orders are decreasing. Thus index has proved to be a good leading indicator since 1982, decreasing leading up to the beginning of recessions, and increasing as the recessions come to an end. Since the ’08-’09 recession, ISM New Manufacturing Orders has been declining, and most recently slipped below 50, thus receiving a score of -1.
LE3. University of Michigan Consumer Sentiment Index. This Indicator shows when consumer are willing to spend more, or in the case of during the recessions, when consumers are willing to spend much less. Consumer spending makes up for nearly 70 percent of U.S. GDP; therefore this indicator is a good representation of the likelihood of consumer future spending. Consumer sentiment has recovered from the ’08-’09 recession to nearly the heights seen in the peak of 2004. This indicates that consumers are optimistic about the future, and are willing to spend more. We assigned this indicator a score of +1.
LE4. Interest Rate Spread: 10-Year T-Note Yield Minus Fed Funds Rate. The Interest Rate Spread represents the difference between the yield on a 10-year Treasury note and the shorter-term Federal Funds rate. This is a popular business cycle indicator since it shows the slope of the Treasury yield curve. Historically this index has been a good predictor of recessionary periods. Prior to the last three recessions the interest rate spread has contracted significantly. Since recovering from the most recent recession, interest rate spread has been trending downward. Since 2015 the rate spread has been consolidating around 2 percent, if it remains in consolidation this could represent an economic slowdown. However, if it slips out of consolidation and continues trending downward, this indicator could be warning of a possible economic recession. We gave this indicator a score of 0.
LE5. Nominal and Real Durable Goods Orders. Nominal and Real Durable Goods Orders represents consumers willingness to purchase big-ticket items, the more willing consumers are to buy these long-term goods, then they are likely feeling optimistic about future economic activity. Nominal and Real Durable Goods Orders dropped nearly 60 percent during the ’08-’09 recession. Since then durable goods orders has been trending upward with a brief spike during 2014. Since spiking in 2014 durable goods orders appear to be in a state of consolidation, which could mean that consumers have become less optimistic about future economic activity, leading us to a score of -1.
LE6. Nondefense Capital Goods Excluding Aircraft, Aircraft is excluded since it is considered an outlier. This index shows how companies are spending in the economy and serves as a measure for future economic activity due to companies’ confidence. These companies are they are making purchases then they are confident that they will make the sales to justify these purchases in the coming quarters. It is clear that this is a leading indicator because of its behavior leading up to the 2001 recession. This index began to take a fairly steep fall just prior to the 2001 recession. However, in the next recession it doesn’t peak until this point due it was lagging. While it is upward trending for a short time in recent years it has begun to trend sideways making a future forecast for this indicator challenging. We gave this indicator a score of 0.
LE7. This indicator, building permits, new private housing, is an indicator of optimism in the market as it trends upward. This is due to the fact that homeowners and contractors are confident in the market and are willing to take the time and money to create new structures. Notice how in many of the recessions the number of permits began to fall sometime before the recession. Note the growth in permits after the 2008 recession; this steady upward trend indicates consumer optimism. How we may want the recent spike in permits could be significant and this indicator may be finding a peak and begin to trend downward signally a recession. This indicator received a score of 0.
LE8. Unemployment Claims can offer great insight into the general direction of the economy. Initial Unemployment claims in a weakening economy will trend upward. Since the current trend of this indicator is downward, this means we are looking at economic expansion. This indicator seems to be finding a new low over the past couple years indicating a rise could be coming similar to many instances prior to recessions. The conclusion to draw is there is a strong signal that unemployment claims have hit a new low since the last recessions and we could expect the number of claims to rise in the near future, leading us to a score of -1.
LE9. The Chicago Fed National Finance Conditions Index is a good measure of future economic activity since it measures the accessibility of credit within the economy. As the index values increase, credit becomes more difficult to attain, and economic activity slows (as is shown by peaks prior to the 2001 and 2008 recessions). The current index value of -0.4 represents relatively loose credit throughout the economy, and provides for an increase in economic activity as the economy continues to expand following the recession. In conclusion, the level of credit accessibility within an economy is important for sustaining economic growth, and this indicator seems to be trending upward towards more strict credit in the future. This indicator was given a score of +1.
LE10. This indicator measures stock prices with and without adjusting for inflation. The indicator correctly predicted the 2001 recession with a steep decline prior to the economic slowdown, but then continued to fall after the recovery began. Conversely, the indicator missed the beginning of the 2008 recession but correctly predicted the economic rebound. Since 2010, prices have been on a strong upward trend as investors continue to buy, and, when adjusting for inflation, are reaching levels not seen since 2000. In conclusion, upward trending stock prices indicate an expanding economy. We gave this indicator a score of 0.
Real GDP growth measures the change in the market value of all final goods and services produced within the United States, adjusted for inflation. The indicator is considered a leading indicator as it falls prior to recessions and rises as the business cycle turns upwards. Real GDP growth in the past 15 years trends around 2.0%, with a drop to -4.6% at the bottom of the 2008 recession. Recent growth has been in consolidation, trending sideways and currently in the a 1% downtrend since mid 2015. Score: 0
The Chicago Fed National Activity Index is designed to gauge overall economic activity along with related inflationary pressure. The monthly indicator trends downwards leading into recessions and recovers months before the recession ends. The index has been trending sideways since the 2008 recession; with a slight downwards trend between 0 and -1 since 2012. The index's slight downward trend notes the beginning of economic downturn. Score: -1
The under and unemployment rates measure the percent of the labor force that is out of work. Under and unemployment is considered a leading indicator because it acts ahead of the business cycle. Under and unemployment has been dropping steadily since the 2008 recession, with no upwards trend yet. Decline in under and unemployment has been sharper than the previous declines post-recession, declining from a high of 17% post-2008 recession to a still-falling 10% eight years later. Underemployment has dropped to a pre-2008 level in 2016, for the first time since the 2008 recession, sending a positive signal as under and unemployment is in a consistent downtrend. Score: +1
The Core CPI represents the aggregate of prices paid by urban consumers for a typical basket of goods, less highly the highly volatile food and energy, while the Producer Price Index is measures the aggregate prices of a basket of goods from a seller. The CPI percentage change has risen leading into the recession of the early 1990s and 2000s, but fell 1.5% prior to a .5% jump into the 2008 recession. Over the graph's 30 years, the CPI growth produced a downward-drifting trend, remaining above the PPI until mid 2008. The PPI fell below the CPI late 2009, then rose above the CPI 2010 through 2012. CPI has risen and remained above since 2013, and both indicators have been in consolidation since 2014. Score: 0
Total Public Debt measures the total federal debt, while debt to GDP is a ratio of debt over GDP to determine ability to cover federal debt. Total federal debt grew at a rate of $250B per year until doubling in 2001, until rising at just over $1.2TR from 2008 through today. Debt to GDP rose 40% from 2008 to 2013, and continues to hover around 1.0, or total federal debt equaling total GDP. Debt to GDP has fluctuated minimally around the 1.0 mark since 2013, indicating a maintenance of debt by GDP but no significant decrease. GDP growth is supporting the ratio as total debt has grown but debt to GDP remains constant around 1.0. Score: -1
Gas price per gallon is a measure of the average price of gas from 900 retail outlets, while oil price is measured by West Texas Intermediate. Both gas and oil prices move together, though gas prices only fell below oil prices briefly at the end of the 2008 recession. Prices rose prior to the 2000 and 2008 recessions, with increased volatility marking the three years prior to the Great Recession. Oil prices have remained around $20 less than the high of $130 in 2008, though gas prices in the past five years have peaked dangerously close to the high of $4.00/gallon recorded in 2008. Oil and gas prices have risen over 100% since 2008 and have recently seen increased volatility, both trends leading to economic downturn and recession. Score: 0
Real disposable personal income measures gross income less taxes, adjusted for inflation, while after-tax corporate profits measure profits of businesses, less taxes. Corporate profits are considered a leading indicator as it falls prior to recessions and rises prior to expansions. Real personal income has maintained consistent growth since 2013, rising $500B per year. Corporate profits have realized a $1.1TR growth since 2009, and the recent upwards trend since 2013 indicates an expansion. Score: +1
The 2015 Washburn University Applied Portfolio Management Class: From left to right: Travis Hirt, Arek Kozaczuk, Dr. Weigand, Brandon Holle, Mark Latimer, Bryan Lunzmann, Jia Liu, Dakota McMahon, Chris Carson, Alexander Anguiano, Sam Olberding, Brea Schmidt (BBA 2013), Harshad Phadke and Bobby Florence (BBA 2014).
March 2, 2015. The Spring 2015 Applied Portfolio Management class’ macro-finance outlook is published below. The overall analysis is represented by the two following graphs, which rate the quality of The Conference Board’s Lagging, Coincident, and Leading Indicators. The first graph is created using The Conference Board’s weighting system. The analysis shows that the U.S. economy grew moderately in 2014 (lagging score = 41%), and that economic conditions in Q4 2014 improved considerably (coincident score = 100%). The leading score of 49% suggests that this surge was temporary, however, and that the U.S. economy is likely to settle back into moderate real growth of +2.0% to +2.5% per year.
The second graph is created by applying equal weights to all of The Conference Board’s indicators. The analysis confirms that the U.S. economy grew moderately in 2014 (lagging score = 29%), and that economic conditions in Q4 2014 improved considerably (coincident score = 100%). The leading score of 70% suggests that this surge may continue, however, and that the U.S. economy is likely to expand at a more rapid pace in 2015 (leading score = 70%), perhaps as fast as +3.0% per year.
There is strong evidence that the employment picture in the United States continues to improve. A strong dollar is weighing on exports which may hurt domestic producers, however, cheap commodities is working to suppress an increase in trade deficit. Manufacturing sales, personal income, non-farm payrolls and industrial production are all signaling that currently the economy is in a state of expansion. However, consumer sentiment has a role to play in the direction of the economy going forward. If consumers are happy with economic conditions they will act like it by ramping up purchases etc. The reading of consumer sentiment gives us pause, coupled with a rise in unit labor cost gives us an indication that we are in the middle of an expansion cycle, means that while things are going to keep growing, we predict that they will grow at a slower rate, but that we do not expected an actual decline in the near future - which is what our diffusion index say. While we do have our hesitations about the future, nothing indicates a certain immediate impending disaster. Our conclusion would be that we are in the middle of an expansion, but should be vigilant in continuing to monitor leading indicators.
A detailed analysis of the lagging, coincident and leading indicators, as well as several supplementary indicators, appears below.
Average Prime Rate
LA-1. The Average Prime Rate is a benchmark interest rate used by lenders for setting the interest rates at which new loans are created. The indicator trails the economy as banks adjust the price of credit. Once the economy has been expanding for a while, and the demand for credit is growing, banks can mark up the price of credit and charge more. After the economy has slowed down, and demand for credit weakens, banks need to put credit on sale to attract new borrowers, and interest rates fall. From the graph we can see that this indicator has not been reliable. During the past two recessions the indicator acts more like a leading indicator. Since 2008 recession, the prime rate has been artificially maintained at extremely low level by Federal Reserve’s zero interest rate policy. This has encouraged the businesses to borrow more, and as the graph shows commercial/industrial loans have peaked at an all-time high in recent year. It is difficult to interpret this indicator in the current circumstances, and thus we give it a score of 0.
Ratio of Consumer Credit to Personal Income
LA-2. The Ratio of Consumer Credit to Personal Income measures consumer’s balance between income and debt levels. Following the 1981 and 1991 recessions, the ratio of consumer credit to personal income shows that consumers waited to increase borrowing for at least several months after the recessions ended. Consumers waited to borrow until tangible signs of an economic recovery were present. Notably, from 1984 to 1986 and 1994 to 1996 the ratio of consumer credit and income reaches a trough because personal income has risen for a period and consumers try to maintain a balance between the two variables. Throughout the 2002 recession the ratio continues on an uptrend and does not perform as a lagging indicator. At the end of the 2008 to 2009 recession consumers offset the loss of income by increasing borrowing relative to income. Following the recession the ratio decreases as income grows and consumers reduce debt. Currently, the ratio displays an upward trend with no trough conveying consumer confidence in the economy and an increase in borrowing. As a result we will score this indicator + 1.
Consumer Price Index, Services
LA-3. The Consumer Price Index, Services measures the service sector inflation. The CPI increases sharply several months after the economy is in recession, and decreases sharply several months after the economy is in expansion. From the graph we can see that during period 1998-2000, the indicator moved up and down sharply, giving a false indication of recession and expansion of the economy. Apart from this one exception, the indicator has worked well as a lagging indicator in previous years. The sharp decline of the CPI several months after the end of 2008 recession correctly confirms the expansion of the US economy. The economic indicator has proved reliable and thus we assign it a score of +1.
Inventory to Sales Ratio
LA-4. The Inventory to Sales Ratio Index measures the amount of inventory held as a percentage of sales. As you can see during 2001 and 2008-2009, Inventory to Sales Ratio peaks in the middle of recessions, when retail spending is down, and decrease in economic expansion, when spending is higher. As you can see over the past few years the ratio has remained between 1.27 and 1.31, which shows a rather sluggish sideways movement. There have been no drastic decreases in the ratio since 2009 which would show excessive retail spending. In conclusion the ratio’s recent minimal and slow movement merits its scoring of 0.
Total Consumer Credit and Commercial and Industrial Loans
LA-5. The Total Consumer Credit and Commercial and Industrial Loans indicator reveals the amount of credit businesses and consumers have outstanding which has dramatically increased since the 90's. The larger the debt held the longer and more difficult it becomes to get out of debt, as the graph demonstrates. 2008 was the most amount of debt held until (at that point in time) a recession began. It took longer to bounce back and dropped sharply possibly due to the FED buying a huge chunk of bad debt. The FED has also kept interest rates artificially low, so this indicator isn’t as reliable. This indicator receives a score of 0.
Index of Unit Labor Costs
LA-6. The Index of Unit Labor Cost measures nominal and real amount of labor cost per worker. Unit labor cost is expected to peak midway through recessions followed by a decline or movement sideways over the next few months into the expansion. Note that nominal labor costs have been rising since 1992 and peaked both before the 2001 recession and in the middle of the 2008 recession, and has continued sideways after both recessions. Real labor costs have been on a downturn slope since 2001, this suggests that the costs increases haven’t been able to keep up with the rate of inflation. It is a good sign that nominal unit labor costs have continued to increase after the most recent recession, but this is offset by the decrease in real unit labor costs. In conclusion we believe the continuing downtrend in real unit labor costs gives this indicator a score of 0.
Duration of Unemployment and Labor Force Participation Rate
LA-7. The Duration of Unemployment and Labor Force Participation Rate delves into how much of the population in unemployed and the percentage of those in the civilian non-institutional population who participated in the labor force by either having a job or actively seeking one in the past four weeks. It's no surprise that after one of the larger recessions the US has experienced in the beginning of the 21st century, that the duration of unemployment had drastically risen until it fell back down to a 90's range of 65%. As for the Labor force participation rate, it seems many workers are still discouraged from joining the workforce as the rate continues to plunge even after 2014 into 2015. This indicator does not seem too consistent and therefore receives a score of 0.
Manufacturing and Trade Sales
CO-1. This graph shows total retail sales excluding the food services industry. Historically this has been an unreliable coincident indicator, as it has only been tracked through the last two recessions, and only coincided with one. The failure of this graph to coincide with the 2001 recession can be largely explained by the increase in the consumer credit ratio (shown below in the lagging indicators). It is currently considerably higher than it was before the start of the last recession, and seems to be trending upward. With consideration of external circumstances, this metric has been a reliable coincident indicator, and is currently giving a bullish signal, so it deserves a score of +1 on the diffusion index.
Total Nonfarm Payrolls
CO-2. This metric measures the number of Americans who are employed in nonfarm jobs. For the last three recessions this has been a reliable coincident indicator. It also begins to show signs of weakness just before recessions. It is currently at an all-time high, as it continues to increase nominally and increase its velocity. As such, this indicator signals that the economy is in a strong boom phase and should get a score of +1 on the diffusion index.
Personal Income Less Transfer Payments
CO-3. The Personal Income Less Transfer Payments is a measurement of growth in the United States based on personal income from base sources in the market, and excludes transfer payments (any form of tax revenue redistributed from the government). It has trended as a coincidental indicator showing only a slight leveling-off of the curve during recessions except during the 2008-2009 recession (where it lagged behind the business cycle for several months). Still, 2008-09 looks to be an outlier when compared to other recessions. In the recession of 2008-09, the Personal Income Less Transfer Payments fell from its current trajectory (indicating a temporary drop in personal income), but nonetheless reassumed its original upward course. This has led the indicator to new current all-time highs. Based on the current trend and past consistency, the Personal Income Less Transfer Payments will receive an indicator score of (+1).
CO-4. The index of industrial production is a coincident indicator that measures physical output at all stages of production in the manufacturing, mining, and gas and electric utilities industries. The index is thought to have a strong positive correlation with changes in total output. Both the nominal and real indexes work well as a coincident indicators, although both behaved more like leading indicators heading into the 2001 recession. Since 2000, the nominal series has had mild positive movement, while the inflation-adjusted industrial production index has trended lower, indicating that total industrial output in the United States has grown more slowly that the rate of inflation over the past 14 years. Although both series have been increasing since the end of the last recession, the inability to exhibit much growth over the past 14 years sends a concerning signal regarding long-term economic growth in the United States. This indicator merits a diffusion index score of +1.
Average Length of the Manufacturing Workweek
LE-1. The Average Manufacturing Workweek indicates the amount of demand for manufactured goods by the economy requiring manufacturing workforces to work longer hours to meet demand, opposed to hiring more employees. The average work weeks seems to be in a slow growth a little above 42 hours per week after the last recession, while the manufacturing workforce has moved up slightly from last year. The manufacturing workweek has been consistently near 42 over the last year and employment numbers have risen slightly. Conclusion: The indicators are not producing strong enough signals to indicate a positive or negative score (0).
ISM New Manufacturing Orders Index
LE-2. The ISM New Orders Index indicates the increase or decrease in manufacturing orders. A new order value greater than 50 indicates an increase in the amount of new orders, while having orders less than 50 means orders are decreasing. The orders are in the high 50 range, indicating new manufacturing orders are increasing at a health level. Conclusion the indicator is positive, scoring (+1).
LE-3. University of Michigan: Consumer Sentiment is a leading indicator and describes how optimistic consumers are about the economy. In times of economic expansion the indicator rises and decreases just before recessions except in 1990 (which fell during the recession). It has shown very unpredictable shifts in between recessions, which could contribute to misleading impressions. Currently this indicator is on a gradual uptrend and is signaling some improvement with regards to consumer optimism. However, the current levels are still well below previous highs before the recession of 2008. Conclusion: Based on the information provided consumers current optimism about the economy is still in doubt. (0)
Rate Spread: 10-Year Yield Minus Fed Funds Rate
LE-4. Int. Rate Spread (10-yr minus Fed Funds) indicates the variance between the 10-year T-note yield and the Fed Funds rate. Before the three last recessions, interest rate fell meaning that investors were looking for security in anticipation of lean economic times. As economic expansion occurs, investors sell bonds and rotate into other investments with higher risk and higher expected return. The yield curve is still relatively far from its lowest points, below zero, which occurred before the previous three recessions (1989, 2000, 2007). Conclusion: The indicator is still well above zero indicating current economic expansion. (+1).
Manufacturer's New Orders for Durable Goods
LE-5. The Manufacturers’ New Orders for Durable Goods measures how much consumers are willing to spend on durable goods that last longer than one year. If consumers commit to larger-ticket purchases, they are probably feeling more confident about future economic activities. Specifically, during the 2008-09 recession, the durable goods purchase fell sharply. Conclusion: the real durable goods orders line is above the nominal durable goods orders before the 2008 recession, but it reverses after the 2008 recession. So I give this indicator a score of (0).
Financial Conditions Index
LE-6. The Chicago Fed National Financial Conditions Index measures the accessibility of credit within the economy. A positive index indicates that it is difficult to attain the credit and the economic activities are slow. A negative index indicates that it is easier to access to credit and the economy expands. The current index value is -0.64, indicating that borrowing conditions are relatively easy and economic activities are expanding in the United State. Conclusion: the level of credit accessibility is under zero after the 2008 recession, which is a good reason for this indicator to be rated. (+1)
LE-7. The figure below shows that the nominal S&P declines in advance to the 2008-2009 recession and continues to do so until the end of the recession. It appears that share prices don’t do a good job predicting the recession of 2008-2009; especially when NASDAQ’s index is mirroring the walk of the S&P 500. The S&P 500 then increases as investors regain faith in the recession and more debt is issued by the government. This follows the pattern of the NASDAQ Index. No advancing declines within the last six to nine months significant enough to promote another recession; but with previous trends with the NASDAQ, before recession’s hit, share prices were at an all-time high. The economy is definitely in an expansion with the share values going up therefore the S&P 500 gets a leading indicator level of a +1.
Manufacturers' New Orders for Capital Goods
LE-8. Capital goods are the long-lived assets in which businesses invest. Increased long-term investment by businesses signals optimism for the Economy. Excluding the two periods during the recession, long-term investing seems to increase at a slow and steady growth. After the recessions they tend to peak back to their average of about 68,000 (millions of Dollars). Currently the New Orders of Capital Goods (excluding aircraft) is leveling off just above that of the average peak which leaves me to conclude that this is another indicator of +1.
New Unemployment Claims
LE-9. A solid indication of the general direction of an economy is the measure of unemployment claims. If economic activity is slowing, firms are paring back their overall workforce and claims will rise. The opposite is true during economic expansion. A level of claims below 400,000 is generally considered to be expansionary, which has been the case since about November 2011. In each of the last 3 recessions, initial claims rose slightly ahead of the recession, adding validity and consistency to the signal of the indicator. The conclusion to draw is that there is a strong signal that unemployment claims are declining and economic expansion is expected to continue in the near to intermediate term. (+1)
New Housing Permits
LE-10. Generally, an increase in the number of new private building permits is a sign of optimism, not only by individual households but by contractors who build houses. Notice how permits began to fall some time before the recession of 2008 indicating that individuals and builders had scaled back their interest in new housing construction. Pay particular attention to the growth in permits since the bottom in late 2009, the steady growth in new permits points generally in a positive direction for continued consumer optimism. Taking into consideration the general uptrend in new housing permits since the end of the last recession absent of any pointed or long term decline, we expect economic expansion to continue. (+1).
Ratio of US Debt to GDP
Since the recession of 2007, the Debt/GDP ratio has grown from about 64% to more than 100%. The total US debt has grown from 9.4 trillion dollars to about 17.8 trillion dollars. Economies cannot sustain such high levels of debt for long time. Research suggests that economies with Debt/GDP ratios over 1 usually grow at much slower pace than that of economies with Debt/GDP less than 1. Fed has already stopped its QE program, and might start increasing the interest rates soon. That will decrease the pace of economic expansion, and in turn the ratio of debt to GDP will rise further. In conclusion we think that the growth of US economy will be sluggish in the near future.
Unit Labor Cost Rise
Recently Walmart announced that by fall 2015, most of their employees will receive raises taking them up to $10/hour. That is an increase of about 25% in one year. Along the same lines, cities like Seattle and San Francisco have raised their minimum wage to $15/hour. We can interpret that the labor supply is getting thin as unemployment rate is falling to its pre-recession levels, and the companies are now trying to get the employees by increasing their wages. The Unit Labor Cost index has already reached an all time peak, and the Real Unit Labor Cost index has been trending sideways since 2012. Although, going forward we might see an uptrend in the Real Unit Labor Cost Index. Unit Labor Costs tend to rise late in a business cycle expansion, so this might be an early warning that the current economic expansion is getting a little tired.
Real Gross Domestic Product
The percent change in real GDP on a quarterly basis from the year prior is positive, indicating that GDP is growing relative to its position one year ago. If we were to overlay a chart depicting real GDP, it would be a further indication that the economy is continuing to expand and a declaration of expansion has not taken place. Particularly interesting to note is that the percent change over a year ago has only been negative during three of the last 4 recessions, and the largest decline in percent change in GDP was in the 2007 recession. However, GDP growth rebounded almost as quickly as it declined during 2007 and has treaded at approximately 2.5% growth from the previous year since 2011.
Trade Balance and Trade-weighted US Dollar Index
Trade balance is the difference between a country's imports and its exports. It is usually the largest component of a country's balance of payments. The trade-weighted US dollar index, also known as the broad index, is a measure of the value of the United States dollar relative to other world currencies. From the graph we can see that US is running a trade deficit for more than two decades, which represents an outflow of domestic currency to foreign markets. It is particularly interesting to note than from year 2001 onwards, the trade balance has displayed a positive correlation with the trade-weighted dollar index. During, and after recent recession of 2007, the dollar is being considered a safe haven by the investors and has appreciated significantly, resulting in the reduction of the trade deficit. Also, since 2005, the shale energy revolution is having a major impact in reducing the U.S. trade deficit, and strengthening the dollar value. We think that in the near term, the relative strength of the dollar will continue to suppress the trade deficit. This is not viewed as a bane to future growth and signals that US firms are continuing to import foreign goods.
Consumer Price Index
The consumer price index is a general measure of consumer facing inflation. Its normal steady upward trend has been slowed or reversed during the last two recessions, where it has acted as a relatively effective coincident indicator. In the last half of 2014, the index slowed down and began to fall. This indicates that the economy at large may be undergoing a period of deflation. Deflation itself may not be inherently bad, but when consumers and business are so highly levered, it threatens to make their debt situation much worse. As it stands now, it’s not enough to call a trend. However, the last data point was in December 2014, so this indicator bears watching frequently, in case the downtrend extends and becomes meaningful. Coupled with other indicators such as debt to GDP, this could signal a bear market
Falling gas prices mean more disposable income for consumers to spend elsewhere. We currently have yet to see a drastic pickup in consumer spending as the relative increase in disposable income hasn’t shifted consumer’s appetite for new goods purchases. Although energy prices have rebounded slightly, the decline in the number of U.S. rigs drilling for oil has slowed, raising worries about oil inventories that were already at record highs. Recently, Goldman Sachs and Morgan Stanley cautioned about rising supplies and their impact on prices.
Data from the Federal Reserve Economic Database.
Macro-Finance Outlook February 2014
The Applied Portfolio Management students’ economic outlook for 2014 is presented below. After analyzing each of The Conference Board’s leading, coincident and lagging economic indicators, each series is scored +1, 0, or -1 and averaged into a diffusion index. Comparing the 3 diffusion indexes provides insight into the past, current, and future strength and resiliency of US economic activity.
The students’ overall economic analysis is depicted in the diagram below, which shows that past and current economic activity has been tepid (as reflected by the lagging and coincident indicators), but future economic activity is expected to accelerate substantially (as reflected by the leading indicators).
Leading Economic Indicators
The students’ scores for the leading indicators are shown in the table below. Their analysis of the individual components of the leading index follows.
The average workweek measure tells us that manufactured goods is being demanded by the economy which makes the manufacturer need their workforce to work more in order to meet the demand, as opposed to hiring more employees. The average hours in a workweek is increasing to almost 42 hours since the recession, while the manufacturing workforce remains the constant. The manufacturing employment staying steady while average hours rise indicates that the same amount of people are employed but working longer hours/week. Conclusion: With the two graphs not coinciding, as they should, the indicator reads a score of (0).
This indicator tells us whether manufacturing orders are expanding or contracting. A new order value that is greater than 50 means new orders are increasing, while a value less than 50 means new orders are decreasing. Notice how the value is strongly above 50 and barely above 60, indicating that new manufacturing orders are on the rise and show signs of staying above 50. Conclusion, this indicator is rated at (+1).
The University of Michigan Consumer Sentiment Index measures consumer optimism in the economy. The data in the graph show that this measure gets mixed reviews as a leading indicator since 1982. While the drop in consumer confidence appears to have preceded the recessions of 2002 and 2008, it acted as a coincident indicator in 1990 and even seemed to lag the expansion in 1983. With the exception of a steep decline in late 2011, the indicator has generally been trending upward since the last recession but has yet to reach the pre-recession levels. Conclusion: Consumers remain nervous about the economic recovery but confidence is slowly returning. (+1)
This indicator measures the difference in interest rates between 10 year T-notes and the federal funds rate. When the graph falls, as it has prior to the last three recessions, investors are buying bonds and driving down interest rates as they seek safety in expectation of lean economic times. Then, as the economic future brightens, investors sell bonds in favor of investments that provide a higher return which causes the spread to increase. The data shows that interest rate spreads remain high as investors continue to prefer the higher returns provided by equities versus the safety (and lower returns) of bonds. Conclusion: Investors remain optimistic about the economic future and spreads remain high as prices of bonds have fallen to reflect preference for risk and return. (+1)
This index indicates how much consumers are spending on durable goods (items that last longer than one year). If consumers are willing to commit to larger-ticket purchases, they are probably feeling more confident about future economic activity. Specifically, during the 2008-09 recession, consumer spending on durable goods fell sharply. Conclusion: Ever since 2009, durable goods orders have been on the rise which is a good reason for this indicator to be rated (+1).
The Chicago Fed National Finance Conditions Index is a good measure of future economic activity because it measures the accessibility of credit within the economy. As the index value increases, credit becomes more difficult to attain, and economic activity slows (as is shown by peaks prior to the 2001 and 2008 recessions). The current index value of -0.6 represents relatively loose credit throughout the economy, and provides for an increase in economic activity as the economy continues to expand following the 2008-2009 recession. Conclusion: The level of credit accessibility within an economy is important for sustaining economic growth, and this indicator seems to be trending upward towards more strict credit in the future. (+1)
This indicator measures stock prices with and without adjusting for inflation. The indicator correctly predicted the 2001 recession with a steep decline prior to the economic slowdown, but then continued to fall after the recovery began. Conversely, the indicator missed the beginning of the 2008 recession but correctly predicted the economic rebound. Since 2010, prices have been on a strong upward trend as investors continue to buy, and, when adjusting for inflation, are reaching levels not seen since 2000. Conclusion: Rising stock prices forecast continued economic expansion giving this metric a score of (+1).
This indicator serves as a measure of future economic activity because it measures companies’ confidence in the economy in the coming fiscal periods. The idea is that companies will show their economic confidence by purchasing new capital equipment because they believe that they will be able to produce enough products to justify an increase in their capital expenditures. While there was a spike and fall prior to the 2001 recession, but not in 2008; the indicator correctly predicted the following recession by undergoing a period of sideways movement prior to the recession. Also, the indicator almost coincides with the end of the recessions by showing a drastic increase in both instances. Conclusion: Although spending on capital goods has increased in recent years following the 2008-2009 recession, real spending on capital goods has only recently approached the levels experienced prior to the recession. Because the overall trend is positive, but the real spending is still lackluster, I give this indicator a score of (0).
Initial unemployment claims work as in indicator by forecasting the strength of the economy. Businesses lay off workers as the economy weakens, which causes an increase in the initial claims for unemployment benefits. The opposite occurs when the economy is expanding; and businesses hire more workers, which causes unemployment claims to drop. The chart above clearly shows that initial unemployment claims rose at a considerable rate before, and during, each of the last four recessions. You will also notice that unemployment claims began to drop right as all of the previous recessions ended. Since the last recession ended in 2009 unemployment claims have been trending downward at a steady rate to levels that are near what they were before the recession in 2008. In conclusion, the steady decrease in initial unemployment claims seen since 2009 leads me to score this indicator a (+1).
Building permits for new private housing measures the optimism of homebuilders and prospective new buyers in the housing market. An increase in new building permits is a sign of optimism, while a decrease in the number of new housing permits is a sign of pessimism. This indicator clearly predicted the 1991 and 2008 recessions based on the sharp decline in new housing permits being issued. It did not predict the 2001 recession however, as housing permits simply trended sideways during that time period. Presently, the number of new building permits has been rising at a slow but steady rate after trending sideways for a short time following the end of the 2008 recession. Even though the number of new housing permits is on the rise; the number is still only slightly above where it was at the end of the 2008 recession, which causes me to score this indicator a 0.
Coincident Economic Indicators
The students’ scores for the leading indicators are shown in the table below. Their analysis of the individual components of the leading index follows.
When nominal and real retail total sales rise, consumers and businesses feel more confident about current economic activity. In 2008 it performed as a coincident indicator, declining during the recession, and in 2009 it increased as the economy expanded. However, during 2001 it trended sideways and the total sales did not indicate a recession. The indicator has increased since 2009 and dramatically in 2012 while hitting new record highs. However, new reports suggest an unexpected dip in retails sales. Since there has been a strong growth in sales over the past couple years, while just tapering off as of recent, an indicator score of 0 is applied.
When the total nonfarm payrolls are rising, it signals a bullish market in the sense that more nonfarm employees are on the payroll and vice versa for a bearish market. In the years of 1982, 1990, 2002, and 2008, the coincident indicator shows a dip at the start of the recessions and then signals an expansion about a year after the end of the recession. Since 2010, the indicator has increased every year, almost reaching a new high since the peak of 2008. The economy has created more jobs therefore receiving the indicator score of +1.
Personal income less transfer payment measures the extent to which incomes in the United States are growing from market-based sources, excluding any government redistribution of income. It has performed as a coincident indicator, except during the last recession (2008-2009). Personal income less transfer payments have reached new all-time highs consistently since 2009. Moreover, there is a dip between personal income and PCEs. The dip has an increasing trend. It indicates that the consumer spending decreases. Therefore personal income less transfer payments will receive the indicator of 0.
The index of industrial production measures total physical output at all stages. Both in the nominal and real index, it has worked well as a coincident during last two recessions. Although the real index increased sharply from the last recession, especially during 2012, there is a sideways trend as of recent. Therefore this indicator will receive a score of 0.
Lagging Economic Indicators
The students’ scores for the leading indicators are shown in the table below. Their analysis of the individual components of the leading index follows.
This lagging indicator shows total commercial and industrial loans, along with total consumer credit. The business loans are expected to peak after an expansion, as declining profits increase the need for borrowed funds. Troughs usually occur a year or more after a recession ends. In the graph above, we note that consumer; along with business borrowed funds have peaked just in a few years after the end of each contractionary period. Consumer credit has been in constant rise since early 1980’s. While Business loans has needed more time to peak after the past two recessions. In the past few years, both consumer credit, and business loans continue expanding following the post-revolutionary trough, which provides further confirmation that the U.S. economy has been in an expansionary phase. The graph confirms the U.S. economy is currently experiencing growth. We assign a diffusion index score of +1.
The index of unit labor cost is a lagging indicator that measures nominal and real amount of labor cost per worker. Unit labor cost are expected to peak midway through a recession, then decline or trend sideways until several months into the next economic expansion. Troughs are more difficult to identify and characterize. We note that since 1992, nominal labor cost has been in constant rise, reaching its peak just before the 2001 recession and kept on a sideways trend until its peak again in the middle of the 2008 and continues on a sideway trend in present days. Real unit labor costs have been on a long-term downtrend since 2001, suggesting that these cost increases have been slower than the rate of inflation. The increase in unit labor cost since the last recession points to economic growth. However, this is offset by the continual decrease of real unit labor, indicating that workers’ wages are not keeping up with inflation. We assign a diffusion index score of zero.
The indicator of average duration of unemployment is a lagging indicator that measures the average weeks a person is unemployed. The graph also depicts the labor force participation rate. Decreases in the average duration of unemployment tend to occur after an economic recovery gains traction and employers begin hiring in earnest. The duration of unemployment is graph along with the labor force participation rate, which measures the percentage of U.S. population that is working either full or part time or actively seeking for work. From the graph, we can note that the duration of unemployment kept increasing since the 2001 recession, and reached the all-time high a few years later after the 2008 recession. In past years the duration of unemployment has slowly decreased, however its levels are still considered high. It is also clear from the graph a downtrend in the labor force participation rate since the 2001 recession, currently reaching its all-time low. The duration of unemployment along with labor force participation rate indicates little or no economic expansion. The diffusion index receives a score of -1.
The Average Prime Rate is a benchmark interest rate used by lenders for setting the interest rates at which new loans are created. The indicator trails the economy as banks adjust the price of credit. Once the economy has been expanding for a while, and the demand for credit is growing, banks can mark up the price of credit and charge more. After the economy has slowed down, and demand for credit weakens, banks need to put credit on sale to attract new borrowers, and interest rates fall. Looking at the graph, we can see that during past recessions this indicator is not so reliable lagging index. During previous decades, this indicator has behave as leading/coincident indicator. As the graph shows, the average prime rate has remained at a steady low level of less than 4 percent for the past five years due to the Federal Reserve zero interest rate policy. This encourages business to borrow more as the graph shows commercial/industrial loans peaking the all-time high. Although the business loans are increasing, the prime rate has almost kept sideways for almost 5 years. So we will rate the score as zero.
Ratio of consumer credit to personal income behaves like a lagging indicator. That is because consumers wait to increase borrowing for at least several months after a recession ends when they can see tangible signs of economic recovery. The graph reaches a trough after the recession of 1980 and 1991 because personal income has risen for a period. However, during the 2002 recession, the ratio does not performance as lagging indicator. As seen in the graph, it goes up during the late part of recession during 2008- 2009, which mean customers offset the loss of income by increasing borrowing relative to income. Then the graph decreases deeply after the recession. Now the graph has clear trends to go up which means consumers feel confident increasing their borrowing. So I will score this indicator +1.
The CPI for Services depicts as a lagging indicator, which measures the service sector inflation. During all of the previous recession in 1983 and 2009, the graph decreases several months following a trough at the start of an expansion. But during the 1991 and 2001 recession, the consumer price index for services acts more like leading or coincidence indicator. In the 2012 fall, the index decreases deeply to be at the bottom -1 and rebounds soon to be over 4, then declines again to be at zero. Even though it has a small trends to go up, there is still not sufficient evidence to merit a score as +1. Therefore, the index receives 0.
The Inventory to Sales Ratio Index is a lagging indicator that measures the amount of inventory held as a percentage of sales. During the two recession in 2001 and 2008-2009, the ratio reaches a dramatic peak after increasing for one year, which is driven by the precipitous decline in retail sales. And the ratio declines during the economic expansion. How the index begins decrease before the start of expansion, which does not depict as a lagging indicator. At begin of 2013, the index reaches 1.3 again and acting more like sluggish sideways, but not significant decreasing. Therefore, this index merits 0.
Macro-Finance Outlook January 2014
It's that time of the year -- I can't let the pundits pontificate without throwing my opinion into the ring. This post will take you on a tour of the individual components of The Conference Board's leading and coincident indicators as described in Chapter 2 of my new book Applied Equity Analysis and Portfolio Management. The chapter describes how to analyze the level and trend of each indicator, synthesize your analyses into discrete scores of -1, 0, or +1, enter these values into the chapter spreadsheet (included with the book), and let the spreadsheet average your scores into a diffusion index for each set of Conference Board indicators. We'll start with the leading indicators, which are depicted in the table below, along with the weights assigned by The Conference Board.
We'll start with the Leading Indicators. The most heavily-weighted component is the Average Length of the Manufacturing Workweek (weight = 0.2781), shown below with total employment in the manufacturing sector. The length of the workweek has regained its pre-recession level, which is typically interpreted as a positive signal. Unfortunately, as also shown in the graph, this longer workweek is being enjoyed by 5 million fewer employees in the U.S. since the start of the 2008 recession. Although the length of the workweek is up, the dramatic contraction in manufacturing employment leads me to score this indicator zero, rather than a more optimistic +1.
The second leading indicator is the ISM's New Manufacturing Orders Index (weight = 0.1651). The index has recently reversed its post-recession downtrend, bouncing strongly off its recent low of 50 (suggesting contraction). Notice how previous recessions have been preceded by similar downtrends. I will rate this indicator +1.
The University of Michigan's Consumer Sentiment Index (weight = 0.1551) has also been in a slow, steady uptrend, which merits a score of +1. Notice how the indicator collapsed in late summer of 2011 before Bernanke went to Jackson Hole and vowed to leave the QE spigot on full blast for "as long as it takes."
Interest Rate Spread Between the 10-year T-Note and the Fed Funds Rate (weight = 0.1069). This indicator is really a proxy for the slope of the yield curve. A steeply sloped yield curve indicates economic expansion, while a flat or inverted yield curve indicates slowdown or contraction. The curve has recently steepened, as longer-term rates have rebounded with the expectation of further tapering of the Fed's QE program. This indicator also merits a score of +1.
Manufacturers' New Orders for Consumer Goods (weight = 0.0811). Nominal and real Durable Goods Orders (deflated by the Personal Consumption Expenditure Index, or PCE) are shown below. The indicator rebounds sharply following the last recession, with Durable Goods Orders displaying slow, steady growth back to their levels preceding each of the last 2 recessions. The positive signal conveyed by this indicator merits a score of +1.
The Conference Board's proprietary Leading Credit Index is replaced by The Chicago Fed's National Financial Conditions Index (weight = 0.0794). Lower levels indicate "looser" borrowing conditions. Access to credit remains easy, especially for this stage of an economic expansion, so I'll rate this indicator +1.
Level of the S&P 500 (weight = 0.0381). The S&P 500 is on the verge of breaking out of its secular bear phase. As stock prices are supposed to lead economic conditions by 3-9 months, I will rate this indicator a cautious +1.
The reason for my caution over the level of US (and global) stocks is conveyed by the graphic below, which shows that Central Bank "activity" has fueled stock prices to a considerable degree. I remain concerned over what happens when more significant tapering occurs.
Manufacturers' New Orders for Capital Goods (weight = 0.0356). Unlike the pattern observed in Durable Goods, the Capital Goods Orders index has yet to match its level from prior expansions. The trend is up, however, so I'll rate this indicator zero.
Initial Unemployment Claims (weight = 0.0334). Unemployment claims continue trending lower. This indicator therefore rates a score of +1.
Building Permits for New Private Housing Units (weight = 0.0272). This indicator continues advancing, but only to levels associated with the depths of the 1982 and 1991 recessions. I will therefore rate the indicator zero.
The individual scores for each leading indicator and their weighted and unweighted averages (with possible lows and highs of -100% and +100%, respectively), are shown in the table below. The weighted diffusion index value of +70% is by far the strongest score since the most recent economic expansion began, indicating further acceleration of economic growth through the first half of 2014, and possibly longer.
The prospect of faster future growth was confirmed by a Q3 GDP growth rate of +4.0% (see below). The above analysis of the leading indicators corroborates that this may not be an outlier, but representative of our first year of growth exceeding +3.0% in almost a decade.
Next we'll consider the Conference Board's 4 Coincident Economic Indicators. This set of indicators measures the strength of current economic activity. Retail and Food Service Sales (substituting for The Conference Board's Manufacturing and Trade Sales indicator (weight = 0.5318, shown below)), have risen steadily since the last recession, earning this indicator a score of +1.
Total Nonfarm Payrolls (weight = 0.2597). The US economy is producing jobs, with total employment finally achieving its level from the mid-2000s.
Taking a shorter-term look at payrolls and hiring confirms that the pace of new job creation remains sluggish. I will therefore rate the Total Nonfarm Payrolls indicator zero -- the uptrend is positive, but the level of employment is not sufficient for a +1 score.
Personal Income Less Transfer Payments (weight = 0.1357). Personal income in the US is at an all-time high, which is definitely a positive. Examining the next graph below, however . . .
. . . I also compare Personal Income to Transfer Payments and Personal Consumption Expenditures. Notice how the upward trend in income and spending is strongly supported by an above-trend sruge in Transfer Payments (Social Security, Medicare, Welfare, etc.). Although I have strong concerns about future reductions in Transfer Payments and the effect on spending, I'll rate this indicator a cautious +1.
Industrial Production (weight = 0.0728). Until last year, Industrial Production was the most heavily-weighted coincident indicator. The nominal series looks encouraging, but the inflation-adjusted series displays some convoluted behavior. Although the trend in the nominal series is upward, the lackluster behavior of the real series leads to a ranking of zero.
Merging the above -1, 0, or +1 ratings into a diffusion index provides a score of +50% if all indicators are equally-weighted, and +67% if we use the Conference Board weights. The implication is that growth and economic activity have accelerated in the current period.
A few more charts to wrap up. Unless "this time it's different," historically bullish sentiment is usually a negative sign for equities -- the latest reading of bulls over bears makes me a little nervous:
We also live in a society that abhors discussion of long-term structural problems, like the tens of trillions in underfunded Social Security and Medicare liabilities -- we'll never be able to pay half the "promises" baby boomers are counting on:
It might not be the disparity between rich vs. poor that incites the revolution:
Perhaps it will be the one-time wealth tax that keeps being discussed -- the exhibit below is from a recent IMF report. Just because it worked in Cyprus, I wouldn't count on it working in the US . . .
Of course, much of our short-term prosperity is fueled by the US sinking deeper into debt every day:
Corporate profits as a percent of GDP are at an all-time high, while wages and salaries as a percent of GDP are at an all-time low:
And much of those profits are increasingly concentrated in the financial sector -- even with significant household deleveraging (ah, the power of those hidden fees . . . ).
Overall, there has been a significant pickup in economic activity in the second half of 2013. If the Fed treads lightly with its QE tapering, a real GDP growth rate of +3.0% in 2014 is definitely possible. Longer term, however, income disparity, federal deficits and debt loads, hopelessly underfunded entitlement programs and an increasingly "financialized" US economy present significant concerns -- concerns that US and global stocks seem content to ignore -- until they can't. For the short term, however, US stocks are likely to rally at the slightest provocation, and the outlook for growth and job creation in 2014 looks more promising than it has in any calendar year since the financial crisis.
Macro-Finance Outlook February 2013
Back in December I weighed in with my economic call for 2013 in my Sluggish Business Conditions Expected to Continue post. Now the Washburn University Applied Portfolio Management students have completed their own update to my forecast, which is posted below. The goal of the exercise is to identify the stage of the US business cycle and map that to the corresponding stage of the financial cycle (which leads the business cycle, as shown in the diagram below):
The analysis is used to practice "sector rotation," i.e., put new money to work in the stock sectors thought to perform well at that particular stage of the financial cycle, and allocate away from sectors that are positioned to do poorly.
The APM students' notes and rankings for The the Conference Board's 21 leading, coincident and lagging indicators are provided below. The closest matching variables from the FRED database (research.stlouisfed.org) are analyzed, in some cases replacing proprietary Conference Board metrics, such as consumer confidence and their leading credit index(TM). The students' overall interpretation of economic conditions is depicted in the table and graph below:
The diffusion index values and graph reflect the students' interpretations of the lagging, coincident and leading indicators (reviewed in detail below). Their analysis concludes that US business activity accelerated in early- to mid-2012 (lagging indicators = +87%), and accelerated even further through Q4 and the end of the year (coincident indicators = +93%). Looking forward, however (leading indicators = -12%), their call is that the pace of business activity will cool off slightly, which is in line with the recent surprising contraction for US GDP (-0.1% for Q4 2012). With the pace of economic activity slowing, the students' overall conclusion is that the economy is entering a contractionary phase -- whether it's a mid-cycle slowdown or beginning of a recession remains to be determined -- which means we are just past the peak of the financial cycle, as evidenced by the recent outperformance of "risk-on" sectors such as financials and industrials:
Leading Indicators. The students' ratings for each of the leading indicators, along with the Conference Board weights for each indicator, are shown in the table below, with detailed notes following:
Average Length of the Manufacturing Workweek:
The most highly weighted leading indicator, Average Length of the Manufacturing Workweek, measures the average number of hours worked in a week for US manufacturing employees. Emerging from the 2008 recession, the metric successfully led the market uptrend beginning in May of 2009, shortly before the recession had officially ended. Since that time, the measure has stabilized to its pre-2008 recession levels. It is interesting to note that, although the number of hours in a workweek remains stable, total manufacturing employment has been in a dramatic downtrend that started before the 2008 recession. Overall, it appears that the Average Length Manufacturing Workweek indicator has established a “new normal”, evidenced by stability in the number of hours worked, but a significant decrease in total manufacturing employment. The indicator is rated zero.
ISM New Manufacturing Orders Index:
The ISM New Manufacturing Orders Index is a diffusion index that measures the number of manufacturing orders received by US manufacturers. The index has been highly volatile over the past 20 years, which has hampered its ability to effectively act as a leading indicator. Immediately after the close of the most recent recession, the metric returned to levels sustained prior to the downturn in the economy, but has been balancing itself around the 50 mark throughout the last 18 months. It should be noted the short-term trend in the diffusion index is beginning to mirror the trends prior to the 2001 and 2008 US recessions. Given its sustained trend of volatility, the ISM New Manufacturing Orders Index is expected to continue fluctuating around the 50 mark, which could signal the beginning of a new economic recession if there is any further decline in the index. This indicator merits a -1.
Consumer Sentiment Index:
Reflecting the changes in consumer preferences within the economy, the Consumer Sentiment Index is one of the few economic indicators that is expectations-based. Just prior to the 2008 recession, the index had some marked volatility, but was more stable until around 2007, when a sharp decrease signaled an economic recession. Notice in late 2012 the index dropped sharply, indicating that consumer confidence in the US economy has still been fairly negative since the end of the most recent recession. Despite a relatively upward trend in the Consumer Sentiment Index, the growth has been much slower than in prior years. Overall, the Consumer Sentiment Index is expected to remain stable or begin a downward trend, as consumer confidence in the economy remains at a low point since the commencement of the 2008 recession. This indicator warrants a score of zero.
Interest Rate Spread, 10-year T-Note Yield Less Fed Funds Rate:
The interest rate spread, also known as the yield curve, measures the difference between 10-year Treasury bond rates and the overnight federal fund rates. The slope of the yield curve is primarily influenced by the Federal Reserve Board’s monetary policy and investor expectations of long-term interest rates. In previous business cycles, the interest rate spread has been relatively effective in signaling economic changes; however, in 2008, the metric appeared to lead the recession too early on. Since the close of the recession, the spread has been trending downward, but has remained stable at 1.5%. Overall, given that interest rates are expected to remain low, the interest rate spread is expected to either remain stable or slightly decline over the next 6-9 months, which would send a negative signal regarding future economic growth. This indicator is scored zero.
Manufacturers' New Orders for Consumer Goods:
Measuring the amount of new durable goods ordered by consumers, the nominal and real durable goods orders chart tracks the money spent on items with larger price tags and longer lives. While the chart dropped off severely prior to the 2001 recession, it seemed to take longer to adjust and drop in 2008. Notice that the peak in 2011 for durable goods orders was far below the previous peaks in 2007 and 2000, indicating that while some consumers are ready to purchase items for the long run, others are still wary of economic conditions. After the 2008 recession, orders increased quickly until 2012; from 2012 to the present, there has been a steady decline, which could predict further contraction of durable goods ordered. As the 2011 peak’s downslope is not nearly as sharp as the peak in 2000, one could assume that the market is simply adjusting and the downward movement seen recently will be offset by some upward movement. Therefore, this indicator merits a zero rating.
Chicago Federal Reserve National Financial Conditions Index:
The Chicago Federal Reserve Board (FRB) diffusion index measures how easy or tight credit conditions are in the US. As the value trends downward past zero, the ability for an individual to borrow money in the US becomes easier, characterized by loosened credit restrictions. Just prior to the most recent recession, this indicator peaked just as the recessions was considered to have begun, unsuccessfully indicating a downturn in the economy. The Chicago FRB diffusion index fell approximately 300bps to a low of -1.5% just after 2010 and has slowly recovered. Given the Federal Reserve’s current policy, characterized by ongoing low interest rates since the end of the 2008 recession, the index has been only increasing slightly. Consequently, the Federal Reserve Bank is expected to keep interest rates very low over the 6-9 months, which concludes that the Chicago FRB diffusion index will continue on its slow trend upwards, but will remain below zero, indicating continued loose credit conditions. This indicator will be rated +1.
S&P 500 Stock Prices:
Since stock prices are thought to be forward-looking discounting mechanisms, it is easy to conclude that stock prices should lead the economy. While both the 1991 and 2001 recessions were successfully predicted by this indicator, the recovery in 2002 actually lagged behind until 2003. Notice that we have been in a secular bear market for the last 12 years after stock prices are adjusted for inflation. This means that, while the real stock prices do have a recovery period during the expansion, the peaks have fallen progressively lower in the expansions following the 2001 and 2008 recessions. The most important thing to realize is that right now, the stock market is trending up; though it may not be an explosion of upward momentum, it has been rising since mid-2012 and has not taken a downturn yet. Given the slow trend in the real S&P 500, this indicator merits a score of zero.
New Orders for Non-Defense Capital Goods:
The Capital Goods Orders graph shows spending on capital goods by US businesses. Though the series predicted an economic downturn in 2008, the capital goods orders almost missed the 2008 recession entirely; it was lagging at the beginning of the recession and barely had an upturn before the recession ended. Notice that, although the real line peaks in both 2008 and 2011, these peaks are not even close to the previous high point realized in 2001. The graph shows that capital investments have been contracting for the whole year of 2012 and capital investments have been generally shrinking since 2000. Overall, as we just had a peak in 2011 and these peaks are followed by troughs, further contraction of capital investment can be expected. Consequently, this indicator will be rated -1.
Average Weekly Unemployment Claims:
The Average Weekly Initial Unemployment Claims leading indicator measures the number of people filing for new unemployment benefits. The indicator has an anti-cyclical relationship with the business cycle; a low number of unemployment claims indicates the economy is expanding. In recent years, it has been a relevant indicator in illustrating the economy‘s downward spiral during the 2008 economic recession. Prior to the past 2001 and 2008 recessions, weekly unemployment claims remained low until sharply increasing in the months leading up to the economic recessions. As seen in the graph above, the amount of claims has dropped tremendously since its peak in 2009. Notice how the metric is currently balancing around 375,000 per week, which appears to be relatively high compared to the 1990s. Although comparatively high, recent months show a slight downward trend of average weekly unemployment claims, indicating the economy is slowly recovering from the 2008 recession. The indicator will be given a rating of zero.
New Building Permits:
This indicator measures the number of new private housing construction permits requested by home builders. Prior to the 2008 recession, the number of building permits gradually declined, successfully indicating a recession was about to surface. It is also interesting to note that during the last recession in 2008-2009 the number of new housing building permits reached a 30-year low. Reviewing the metric’s trend over the past few years, steady growth in the number of permits authorized represents a strengthening economy. Overall, the number of building permits for new private housing has yet to surpass pre-recession levels, but is expected to remain trending upward over the near-term. Therefore, this indicator will be rated at zero.
Coincident Indicators. The students' rankings for the Conference Board's four coincident indicators are shown in the table below; detailed notes on each indicator follow.
Manufacturing and Trade Sales:
The indicator of manufacturing and trade sales is a coincident indicator that measures the total retail sales and real total retail sales (accounting for inflation). This indicator acted as a leading indicator in piror business cycles, and as a coincident indicator in more recent years. Both total retail sales and real total retail sales have been on a steady rise since 1992. Total retail sales surpassed real total sales during the 2008-2009 recession. The steady uptrend indicates a growing economy. Retail sales have resumed normal rate of growth since the 2008-2009 recession and are showing a full recovery. This indicator therefore merits a diffusion index score of +1.
Total Nonfarm Payrolls:
Total nonfarm payrolls is a coincident indicator that measures the total number of people in the US with a fulltime/part time job, temporarily or permanent. The total number of nonfarm payrolls has decreased during the recession (2008-2010) but increased since 2010. Total nonfarm payrolls is getting back to the level that it achieved before the recession. The overall trend is going upward. The upward trend and steady increase of the total nonfarm payrolls is indicating a recovering market and economic expansion. For this reason the coincident indicator nonfarm payrolls gets a diffusion index of +1.
Personal Income Less Transfer Payments:
Personal income less transfer payments is a coincident indicator measuring the extent to which income in the US is growing from market base sources excluding any government redistribution of income. US GDP grows by a greater amount when consumers’ spend freely. Personal income is the main source of spending. Transfer payments are redistributions of tax revenues by the government including social security, welfare and business subsidies. The indicator lagged true economic conditions by several months, for instance during the last recession (2008-2010), when it reflected the overall economic situation two months late. Nevertheless, personal income less transfer payments is at an all-time high and increasing. Therefore personal income less transfer payments will receive a diffusion indicator score of +1.
The index of Industrial production is a coincident indicator which measures physical output at all stages of production in the manufacturing, mining, gas and electric industries. Although the industrial sector only represents a fraction of the total economy, this index is positively correlated with changes in total output. The nominal works well as a coincident indicator, increasing and decreasing in sync with economic expansions and contractions. The inflation adjusted industrial production index fails to increase during the 2002-2007 expansion, although it decreases sharply with the 2008-2009 recession and rebounds weakly before resuming a sideways trend. Although both series have been increasing slightly since the last recession, the series did not manage to grow over the past 12 years, which is not indicating current economic expansion. Therefore this indicator will receive a diffusion index of zero.
Lagging Indicators. The students' rankings for the Conference Board's seven lagging indicators are shown in the table below; detailed notes follow.
Average Prime Rate:
The Average Prime Rate is a benchmark used for pricing loans. The indicator trails the economy as banks set the price of credit. The demand for credit will grow if the economy has been expanding, and banks can mark up the price of credit and charge higher rates. Commercial and Industrial Loans depicts the level of the interest rate regardless of total loans outstanding. If new credit is not created due to low rates, the economy may not expand. The Average Prime Rate functions more like a leading indicator heading into recessions as the US Federal Reserve begins cutting interest rates in anticipation of future economic weakness. During the last three recessions, it acted as a lagging indicator, increasing well after the end of the previous recessions. The Average Prime Rate has been in a secular downtrend for the past thirty years, declining with the general decrease in inflation and interest rates for the same period. The Prime Rate has remained very low rate due to the Fed’s commitment to zero interest rate policy ever since the 2008-2009 recession. Low interest rates have contributed to the rebound of commercial and industrial loans. The Prime Rate could not be much lower, and business loans are increasing, therefore this indicator is scored +1.
Ratio of Consumer Credit to Personal Income:
Consumer Credit to Personal Income functions as a lagging indicator. Consumers normally wait to increase borrowing for at least 3 to 6 months after a recession ends and they can see tangible signs of economic recovery. Consumer credit to personal income functions well as a lagging indicator around 1981-1982 and 1991-1992 recessions. During the early 2000s credit bubble, the current value of the series becomes hard to discern. Early in the 2008-2009 recession, the ratio began a sharp decrease, which means consumers offset the lost income during the latter part of recession by increasing borrowing relative to income. As teh recovery began, the ratio declined as income grew and consumers reduced debt. In the recent two years, the ratio began to climb back close to its last high point, which may suggest that total personal income has grown to the point that consumers feel comfortable increasing their total borrowing once again. The series decreases by 1% after each recession, which means consumers still have old debts to pay off before a new cycle of consumer borrowing begins. In the long term, the main trend of this series is upward. Therefore the indicator will be rated as a +1.
Consumer Price Index for Services:
The Consumer Price Index for Services is a lagging indicator that measures the percentage increase or decrease in the cost of services over time. The index only sometimes (1983 and 2009) lags behind the economy, other times (1988 and 1998) it reflects increase in service costs before a recession. Notice how the index increased sharply (4.4%) following the 2008-2009 recession, but has decreased by a greater percentage (7%) since. The index is decreasing on the whole, indicating a decline in the cost of services over time. Note that the index has not reliably lagged behind economic changes. Nonetheless, the comprehensive decrease in cost of services suggests recovery from the most recent recession. This index receives a +1.
Commercial and Industrial Loans:
The index of commercial and industrial loans is a lagging indicator that measures the amount of consumer and commercial borrowing. Troughs in borrowing usually occur a year or more after a recession ends. Consumer borrowing has risen at a faster pace than commercial borrowing. After recessions, commercial borrowing decreases more than consumer borrowing. After the 2001 recession consumer borrowing did not slow down at all. Both consumer and commercial borrowing have reached or exceeded their pre-recession levels indicating the economy has recovered. In the past, borrowing has steadily increased, with the exception of post-recession periods. Currently borrowing is increasing again indicating economic growth. This indicator therefore merits a diffusion index score of +1.
Inventory to Sales Ratio:
The Inventory to Sales Ratio Index is a lagging indicator that measures the amount of inventory held as a percentage of sales. The index reliably decreases by a larger percentage than normal after a recession. Notice how the index increases significantly before or during a recession and decreases at the end of a recession. The index has remained relatively unchanged (between 1.25 – 1.30) since 2010 indicating an Inventory to Sales Ratio similar to pre-recession conditions. Significant increase in Inventory to Sales hasn’t consistently lagged behind economic recessions. However, significant decreases in Inventory to Sales Ratio have reliably indicated the onset of and expansion phase. Therefore, this index receives a +1.
Unit Labor Costs:
The index of unit labor costs is a lagging indicator that measures amount of labor cost per worker and the real amount of labor cost per worker (which considers inflationary effects). Labor cost per worker usually peaks midway through a recession and decreases about a year after a recession. Notice how unit labor costs are increasing while real unit labor costs are decreasing. Unit labor cost increasing indicates U.S. businesses are adapting to higher wage demands from workers. Real unit labor cost indicates the unit labor cost increase has increased slower than the rate of inflation, however. An increase in unit labor cost since the last recession shows economic growth. The continual decrease of real unit labor cost indicates workers' wages are not keeping up with inflation. Therefore this indicator receives a score of zero.
Duration of Unemployment:
The indicator of average duration of unemployment is a lagging indicator that measures the average weeks a person is unemployed. The labor force participation rate is also depicted. Duration of unemployment has increased during recessions and continued to increase for about a year after recessions before slowly declining. The labor force participation rate has steadily been decreasing and not shown any sign of turning around since the 2001 recession. Notice that duration of unemployment hit an all-time high after the 2008 recession and has only recovered about one-fourth to the level it was before the recession. Also, the labor force participation is at an all-time low. Unemployment and labor force participation have not recovered since the 2008 recession. The average duration of unemployment indicates little or no economic expansion. This indicator therefore merits a diffusion index score of -1.
Macro-Finance Outlook February 2012
(Conference Board Weights are shown after each indicator)
Lagging Economic Indicators
Average Bank Prime Rate (28.1%). This indicator moves counter cyclically with the economy. The graph shows that a trough occurred in 2011 and borrowing is increasing. This means that expansion has occurred but it is negated by the fact that the prime rate has stayed low. Conclusion: The demand for new credit has not grown enough to support an increase in the prime rate. (-1)
Consumer Price Index for Services (19.1%). The time series shows an increase in volatility during recessions. Since 2009 the mean is stationary and there are few changes. Conclusion: the indicator currently has no correlation to the current state of the economy. (0)
Ratio of Consumer Credit to Personal Income (18.9%). Consumers will wait roughly a year after a recession ends to start borrowing again. A trough occurred in 2011 and consumer installment credit/personal income has since started to increase along with personal income. Conclusion: The upswing in both of these variables signal that the economy has been growing. (+1)
Inventory to Sales Ratio, Manufacturing and Trade (12.6%). When times are good companies are able to move their inventory more rapidly and consistently. This indicator peaks midway during recessions, and has declined during the 2011 expansion. Conclusion: this is a strong economic indicator that is showing signs of expansion. (+1)
Commercial and Industrial Loans (11.1%). The two time series show peaks during recessions. The trend since 2011 is positive with a steep slope. Conclusion: We have seen economic expansion the last few years and should continue to see increase in business borrowing as the economic expansion continues. (+1)
Unit Labor Cost, Manufacturing (6.2%). Real unit labor costs are rising while the nominal until labor costs are declining. Declining costs are good for business but declining wages are bad for the workers. Conclusion: This indicator is conflicting for the economy. (0)
Median Duration of Unemployment (3.7%). The indicator has reached a much higher level after the 2009 recession that what would be ideal for a recovering economy. The median would be expected to decrease after the recession and has failed to show a significant negative trend. Conclusion: The slow growing economy is not recovering fast enough to replenish the jobs lost during the last recession. (-1)
The summary table of Lagging Indicators is shown below. The unweighted score of 14% and the weighted score of 11% indicate that the US economy grew at a slow pace during Q3-Q4 2011.
Coincident Economic Indicators
Employees on Nonagricultural Payrolls (54.1%). This indicator hit a low in 2010 and has started to rebound since. The rise in employment is a sign that the economy is growing. Conclusion: The rate in which it is growing is not fast enough to merit more than a neutral mark. (0)
Real Personal Income Less Real Transfer Payments (19.1%). This indicator has rebounded to the same level as in pre-recession. However, the time series levels off during the 2011 expansion instead of following the uptrend. Conclusion: the indicator is not rising or falling, therefore it is not a good reflection of the current economy. (0)
Personal Income, Personal Consumption, and Transfer Payments (supplemental). This indicator has rebounded to the same level as in pre-recession. However, the time series levels off during the 2011 expansion instead of following the uptrend. Conclusion: the indicator is not rising or falling, therefore it is not a good reflection of the current economy. (0)
Industrial Production (14.9%). The time series is a very troubling picture of the United States. With decreasing production overall since the 70’s, it is evident that production on our shores will not increase with the economy. Conclusion: the overall trend continues to be a downward slope. More recent data appears to be more white noise than a real significant increase. (-1)
Real Manufacturing and Trade Sales (11.9%). When trade sales and real manufacturing increase the economy grows. This graph shows that both are on the rise. Conclusion: This signals a growing economy. (+1)
The scores of the four Coincident Indicators are shown below. The unweighted score of 0% and the weighted score of -3% indicate that the pace of economic expansion in the US is likely to remain slow for Q1-Q2 2012.
Leading Economic Indicators
Real M2 Money Supply (35.5%). Real M2 has grown steadily since the mid-nineties, while the velocity of M2 displays a long-term decline. Increases in M2 have failed to significantly stimulate consumer and business loans since the recession. Conclusion: Increases in the money supply have been ineffective in generating significant growth. Score: 0.
Real M2 Money Supply and the Velocity of Money (supplemental).
Average Length of the Manufacturing Workweek (25.5%). The Average Length of the Manufacturing and Construction Workweeks formed a trough during the recession in 2009. The average workweek normalized in 2010. Employment in manufacturing and construction has not grown since the recession, however. Conclusion: The current stability of this indicator came at the expense of over 5,000 jobs. Score: 0.
Total Employment in Manufacturing and Construction (supplemental).
Interest Rate Spread, 10-Year Yield Minus Fed Funds (10.2%). The Interest Rate Spread dropped below zero in 2007 and 2008, while investors feared a recession. Rates are falling due to investors reallocating from stocks to bonds in 2011, flattening the yield curve. Conclusion: The Interest Rate Spread indicates that investors are less optimistic about the economy. Score: -1.
The Yield Curve (supplemental).
Manufacturers' New Orders, Consumer Goods and Materials (7.7%). Manufacturers’ New Orders for Consumer Goods plummeted during the recession in 2008 and 2009. New orders increased throughout 2010 and 2011. Conclusion: Despite the low level of new orders, this indicator displays a strong positive trend. Score: +1.
Suppliers Delivery Index (6.7%). The suppliers delivery index was on a steady decline throughout 2011, indicating that business activity is slowing. Conclusion: This indicator receives a score of -1.
Stock Prices, S&P 500 (3.9%). The United States stock market has been in a secular bear market for the past 11 years. The nominal value of the stock market has nearly rebounded from the 2009 recession. The real value of the index displays a long-term decline, however. Conclusion: The S&P 500 Index illustrates a volatile stock market. Score: -1
Average Weekly Claims for Unemployment Insurance (3.1%). Claims for unemployment insurance peaked at the end of the recession in 2009. Though unemployment insurance claims remain high, claims continued to decline at a formidable rate. Conclusion: The steep downward slope in unemployment insurance claims warrants a score of +1.
Index of Consumer Expectations (2.8%). Consumer expectations suffered at the hands of the recession in 2008 and 2009. Conclusion: Consumer expectations did not rebound significantly from the recession and appear to be leveling out. Score: 0.
Building Permits, New Private Housing Units (2.7%). Building permits for new private housing units rapidly decreased from 2006 to 2009. Building permits remain at an all-time low. Conclusion: Building permits have failed to recover from the recession, scoring this indicator a -1.
Manufacturers' New Orders, Nondefense Capital Goods (1.9%). Manufacturers’ new orders made a strong rebound in 2010 following the recession. Growth in new orders slowed in 2011, however. Additionally, manufacturers’ new orders adjusted for inflation reflect a long-term declining trend. Conclusion: The recent growth in new orders is not strong enough to break out of the long-term decline, warranting this indicator a score of 0.
All 10 Leading Indicators are shown in the table below. A leading indicator score of -20% suggests that economic growth will slow in early 2012. Increased demand for consumer goods and declining unemployment will generate mild growth. Investors remain fearful, however, evidenced by the decreasing interest rate spread, the volatile stock market, and a depressed housing market. Poor fiscal policy, domestic political instability, and fears of European default contribute to the secular bear market.
A visual depiction of the Lagging, Coincident and Leading indicators appears in the graph below. The graph depicts the stagnation of the US economy predicted by the above analysis.
Percent Job Losses in Post WW2 Recessions. The recent recession of 2007 caused the largest percent job loss since 1948. At the current rate of job recovery, the American economy will take over five years to regain lost jobs. High unemployment infers lower consumer demand. Conclusion: Economic growth will be stifled by high unemployment.
Case-Shiller Price Cumulative Declines from Peak (SA), Year and City. The most valuable asset for many Americans, their home, declined significantly over the past five years in the nation’s largest cities. Negative equity prevents homeowners from relocating, contributing to structural unemployment. Foreclosures continue to weigh on a struggling financial sector. Conclusion: The housing crisis continues to have a negative impact on the economy.
Ratio of US Debt to GDP. Since the recession of 2007, the Debt/GDP has grown approximately 35% to a ratio of nearly 1. Economies with Debt/GDP ratios over 1 usually grow at half the rate of economies with Debt/GDP less than 1. Conclusion: The large amount of American debt will slow economic expansion.
Core CPI and PPI. The change in Core CPI and PPI increased approximately 3% over the past year, decreasing the purchasing power of the American consumer. Conclusion: High inflation will suppress economic growth.
Macro-Finance Outlook December 2011
This article analyzes the indicators comprising the Conference Board's Lagging, Coincident and Leading Economic Indexes. Each indicator is analyzed individually, scored -1, 0, or +1 for mostly negative, neutral, or mostly positive, and then averaged into Lagging, Coincident and Leading diffusion indexes scaled from -100% (economic free fall) to +100% (robust expansion).
Here's the upshot of the article: The first graph below depicts the equally-weighted diffusion indexes. The Lagging indicator score of +14% corroborates that the US economy was experiencing painfully slow growth during most of 2011. The Coincident indicator score of +25% suggests improving business conditions and accelerating growth late in 2011. The Leading indicator score of -10% suggests that the recent improvement in business conditions will not accelerate further, and the slow-growth environment will persist through the first half of 2012, at least.
If the indexes are calculated using the Conference Board's weights, the results are similar, as shown in the graph below. The Lagging, Coincident and Leading scores equal +11%, +16%, and -11%, respectively.
Conclusion: The Conference Board's Economic Indicators confirm that the US economy grew slowly in 2011. Conditions for growth improved slightly in the 4th quarter. Growth is not expected to accelerate for the first half of 2012, however, and may slow further. The US economy remains vulnerable to the forces that may have already tipped Europe into a recession.
Lagging Economic Indicators
Average Bank Prime Rate (28.1%). Real Total Business Loans are also depicted (red line). A rising average prime rate indicates increasing demand for credit, as banks mark up the price of interest. Thus far the prime rate has failed to turn upwards in sync with business borrowing as it did in 2004. Score this indicator -1, as it fails to corroborate the 2011 economic expansion.
Consumer Price Index for Services (19.1%). This indicator peaks midway during a recession. It has displayed no meaningful trend since 2009. Score this indicator zero for neutral.
Ratio of Consumer Credit to Personal Income (18.9%). Real Personal Income is also depicted (red line). Consumer Credit/Personal Income is expected to display a trough several months after Real Personal Income begins rising, which is exactly what the indicator shows for late 2011. Score this indicator +1.
Inventory to Sales Ratio, Manufacturing and Trade (12.6%). This indicator rises during recessions as inventories accumulate, and declines during expansions. The indicator trended downwards in 2011, thus earning a score of +1.
Commercial and Industrial Loans (11.1%). Both the nominal and real series are displayed. Both series display a significant uptrend, confirming economic expansion as they did in 2004-2005. Score this indicator +1.
Unit Labor Cost, Manufacturing (6.2%). Both the nominal and real series are displayed. Unit Labor Costs are expected to peak midway through a recession, which occurred in 2009. But Real Unit Labor Costs have been in a downtrend for 15 years, which may be good for business, but bad for the working class. Score this indicator zero for a mixed or neutral reading.
Median Duration of Unemployment (3.7%). The Labor Force Participation Rate is also shown. Unemployment Duration is expected to gradually decline as an expansion picks up steam. All official unemployment series get an unnatural boost from not counting the underemployed and discouraged labor force dropouts, however. The staggeringly high median duration of 22 weeks merits a score of -1. It is worth noting that the series took a long time to begin trending downward following the last recession, however, so improvements in this series may be forthcoming.
The summary table of Lagging Indicators is shown below. The equally-weighted and Conference Board-weighted scores of +14% and +11% confirm that the US economy experienced growth in 2011, but this growth was painfully slow.
Employees on Nonagricultural Payrolls (54.1%). Total Nonfarm Payrolls (blue) and Total Nonfarm Hiring (red) are shown below. While both series have indeed turned upward, the US employs the same number of workers as it did in 2001, and is adding new workers at an almost ridiculously slow pace. Score this indicator zero for neutral, as the positive percentage changes are offset by the low level of the series.
Personal Income Less Transfer Payments (19.1%). Real Personal Income Less Real Transfer Payments is shown below. (A more granular view appears in the 2nd graph.) The series has bottomed, but the trend is flat, rather than rising.
Personal Income, Personal Consumption, and Transfer Payments (green) are depicted below. Total Transfer Payments fueled much of the rise in Personal Income over the past 2 years. With Transfer Payments leveling off (and predicted to decline in 2012), growth in Real Personal Income will most likely stagnate for a while. This indicator is right on the border, but the trend is up so I will score it +1.
Industrial Production (14.9%). The Nominal and Real series are shown. Nominal Industrial Production displays a promising rebound, but when adjusted for inflation, the long-term downtrend in the series is more evident. Score this series -1, as it bespeaks an economy in a long-term decline.
Real Manufacturing and Trade Sales (11.9%). Total Household Debt is also shown (as much of the sales growth from the past decade was fueled by debt). The series shows a smart rebound, and merits a score of +1.
The scores of the four Coincident Indicators are shown below. The diffusion scores are 25% (equally-weighted) and 16% (Conference Board weights), respectively, slightly higher than the Lagging Indicator scores. This suggests modest improvements in business conditions and economic growth in late 2011.
Real M2 Money Supply (35.5%). Real M2 is depicted below, along with Real Consumer and Business Loans. The 2nd graph charts Real M2 with the Velocity of M2.
The Real M2 Leading Indicator reveals some of the weaknesses in the Conference Board system, which scores series based on their percentage changes. Real M2 is definitely rising, but not due to market forces (strong demand for credit or liquidity) -- it's mainly driven by Federal Reserve intervention (manipulation?). Neither total borrowing nor velocity (shown below) is rising. Score this indicator zero -- M2 is rising, but the damage from the Fed's loose money policies will most likely plague us for a generation (see the inflation statistics below).
Average Length of the Manufacturing Workweek (25.5%). The average length of the Construction Workweek is also depicted. This is another Conference Board indicator that looks good on the surface, as the Manufacturing Workweek has rebounded to its pre-recession levels.
With a bit more context, the apparently positive signal looks somewhat different, however. Consider Total Employment in Manufacturing and Construction, depicted in the graph below. The length of the respective workweeks was restored at the cost of permanently eliminating 5 million high-paying middle- and working-class jobs. Score this indicator zero, as the rising workweek is offset by signs of a dramatically contracting labor market.
Interest Rate Spread, 10-Year Yield Minus Fed Funds (10.2%). The yield on the 10-year T-note minus the Fed Funds rate is really a proxy for the slope of the yield curve, depicted in the 2nd graph below.
The Yield Curve flattened considerably in 2011. A flattening Yield Curve suggests economic slowdown, so score this indicator -1.
Manufacturers' New Orders, Consumer Goods and Materials (7.7%). Real Durable Goods is depicted along with Consumer Sentiment (the strong positive correlation is evident). This is a tough one to score -- Real New Orders are rising following the last recession, but the inflation-adjusted series achieves lower highs following each of the last two recessions. I had to inject a bit of subjective optimism to score this indicator +1.
Suppliers Delivery Index (6.7%). This index is trending downward for most of 2011, thus meriting a score of -1.
Stock Prices, S&P 500 (3.9%). The Real and Nominal S&P 500 is shown below. The long-term market trend looks flat in nominal terms, but registers as a secular bear market in real terms.
If you're still not convinced, consider the S&P 500 Total Return since 2001 deflated by the value of the US Dollar. The dramatic loss of purchasing power for buy-and-hold investors is clearly evident. This series earns a score of -1. The secular bear market in stocks continues.
Average Weekly Claims for Unemployment Insurance (3.1%). Unemployment is deliberately measured with a positive bias, as workers too discouraged to keep looking are no longer counted. Nonetheless, the series is trending downward, and merits a score of +1.
Index of Consumer Expectations (2.8%). This series displays a sideways trend around a scarily low level, which justifies no more than a score of zero.
Building Permits, New Private Housing Units (2.7%). This series looks like the backdrop graph in a Dilbert comic strip. Too bad the process doesn't allow me to score it less than -1.
Manufacturers' New Orders, Nondefense Capital Goods (1.9%). Real Nondefense Capital Goods orders are shown below. The series is rising strongly, so I will score it +1, but this was a close call, as the long-term trend suggests inexorable slowdown.
All 10 Leading Indicators are shown in the table below. The scores of -10% and -11% suggest that the economy will find it difficult to extend the meager progress seen in late 2011.
Conclusion: The Lagging indicator score of +14% corroborates that the US economy was experiencing painfully slow growth during most of 2011. The Coincident indicator score of +25% suggests improving business conditions and accelerating growth late in 2011. The Leading indicator score of -10% suggests that the recent improvement in business conditions will not accelerate further, and the slow-growth environment will persist through the first half of 2012, at least.
Supplementary Economic Indicators
Ratio of Corporate Profits to GDP. I find it fascinating that the "normal" ratio of Corporate Profits to GDP seems to have doubled during the lost decade in stocks. The "corporatization" of the US has not been good for Main Street.
Ratio of US Debt to GDP. By now, everyone is familiar with the Rogoff and Reinhart (2009) study showing that advanced economies with Debt/GDP ratios greater than 100% grow half as fast. The US is just about there, and borrowing more every time Congress is in session. The trend in total Federal Government Debt is asymptotic, and clearly unsustainable.
U6 Unemployment + Underemployment. The spread between the unemployed and underemployed expanded rapidly early in the current economic recovery. The manner in which unemployment is measured is outdated, and intended to impart a deliberate positive bias to the unemployment numbers.
Case-Shiller Home Price Index. Yet another sharp downturn for the Case-Shiller Index. Markets experiencing extreme real estate bubbles, such as Las Vegas and Phoenix, continue plunging.
Core CPI and PPI. The bean-counters that calculate inflation have done everything in their power to report misleadingly low inflation statistics, but they seem to be running out of tricks. Core CPI and PPI continue spiking to 1980s-type levels.
Real Oil and Gas Prices. Oil and Gas prices have been rising faster than the Energy CPI for decades. This functions as a tax on the US Consumer (collected by large, integrated energy companies). From 2009 through early 2011, commodities prices soared at every sign of global economic strength, which neutralizes economic growth in consumer- and automobile-oriented economies like the US.
Macro-Finance Outlook March 2011
This analysis will begin with an examination of the Conference Board’s leading, coincident and lagging indicators to determine the stage of the current business cycle (e.g., early expansion vs. late expansion). The analysis concludes by considering additional indicators that further reflect the health and vitality of the economy.
The M2 Money Supply (weighted 0.355, in blue below), has been increasing aggressively as a result of the Federal Reserve’s pro-liquidity programs (TARP, Quantitative Easing, etc.). Although rapid growth in the money supply is normally associated with economic growth, thus far all the loose money in the economy has not found its way into new consumer or business borrowing (red and green lines). The extent to which M2 growth is having a positive impact on the economy therefore remains questionable.
The Average Length of the Manufacturing Workweek (weight = 0.255, in blue) began increasing late in the last recession, and has since leveled off. Total employment in manufacturing (in red) has not increased, however -- millions more manufacturing jobs were lost in the last recession.
The Interest Rate Spread, measured as the 10-year Treasury Yield minus the Fed Funds rate, (weight = 0.102), shows that the Treasury Yield Curve now has a steep upward slope, further suggesting continued economic expansion. As mentioned above, however, while a steep yield curve means that banks have a strong incentive to lend, there is little evidence that credit creation is expanding.
The Suppliers’ Delivery Index (weight = 0.067) declines during recessions and then gradually increases until late in the ensuing expansion. Although volatile, this indicator is currently trending upward, suggesting continued expansion of the economy.
S&P 500 Stock Prices (weight = 0.039) have now officially doubled from their low in March 2009. The strong bull market in stocks forecasts continued economic expansion.
Initial Unemployment Claims (weight = 0.031) tend to peak at the end of each recession, then decline as the economy begins to recover. The trend in initial claims indicates that fewer people are losing their jobs, but the current lows are equal to the peak in 2003, suggesting that the pace of layoffs remains elevated. Without robust job creation, the sustainability of the economic expansion remains questionable.
The University of Michigan Index of Consumer Sentiment (weight = 0.028) consistently increases prior to the end of recessions. Consumer sentiment has recovered from its lows in the recent recession, but remains suppressed compared to previous expansions. Sentiment has not been this low since the economy emerged from the 1970s-1980s double-dip recessions.
New Building Permits for Private Housing (weight = 0.027). Following the collapse of the housing market, this indicator is currently at an all-time low and shows no signs of recovery, suggesting painfully slow growth for the housing industry. This would be the first economic expansion in over half a century where the housing market did not participate.
New Orders for Nondefense Capital Goods (weight = 0.018) bottomed out just before the end of the recession, which is typical behavior for this indicator. The strong uptrend in new orders forecasts continued economic expansion, although this indicator did take a large, unexpected dip in January 2011, so it bears further watching.
Total Nonfarm Payrolls (weight = 0.543, in blue), although classified by the Conference Board as a coincident indicator, has behaved more like a lagging indicator in the past two recessions. Nonfarm Payrolls have expanded slightly from their low in early 2010, but the trend is insufficient to regain the millions of jobs lost during the Great Recession. Also shown is Total Nonfarm Hiring (in red).
Personal Income Less Transfer Payments (weight = 0.189) has regained its pre-recession level, but over the last 30 years, Wage and Salary Disbursements (in red) have lagged. The widening gap between the two series indicates the increasing gains in income for individuals who receive a substantial portion of their income from their investments, rather than wages and salaries.
Industrial Production (weight = 0.149) has been a reliable indicator, turning upward at the end of the past 5 recessions. The current uptrend suggests the economy is well into its expansionary phase.
The Bank Prime Rate (weight = 0.282, in blue) and Total Loans and Leases at Commercial Banks (weight = 0.111, in red). The average Bank Prime Rate is lower than it has been in 30 years, suggesting that credit conditions are favorable for growth. Total Loans and Leases at Commercial Banks continue declining, however, albeit at a much slower pace.
The CPI for Services (weight = 0.196) has been of questionable value as an indicator in both of the last recessions. The series currently displays no meaningful trend.
Ratio of Consumer Credit to Personal Income (weight = 0.188) continues plunging, reflecting consumer deleveraging. Also shown is Real Disposable Income (in red). The moderate increase in income suggests that the decline in the Credit-to-Income ratio is mainly driven by a decrease in consumer credit.
The Inventory-to-Sales Ratio (weight = 0.124) is another indicator whose value is questionable, as the ratio has been in a 30-year downtrend due to just-in-time inventory management practices. Inventories are nonetheless low relative to sales, indicating that there is little chance the economy will stall due to an overhang of unsold inventories, so the indicator is generally positive.
Unit Labor Costs (weight = 0.062) have leveled off, but as yet show no sign of increasing. Normally this would suggest that the economic recovery is in an early stage. Currently, this indicator is unlikely to show much of an increase until very late in the expansion, given the large number of unemployed and discouraged workers.
Median Duration of Unemployment (weight = 0.037, in blue). The median duration of unemployment is more than double its post-recession level from late 2002. As a lagging indicator, unemployment duration usually does not decrease until midway through an economic expansion, suggesting that we are in the early stages of the current expansion.
Macro-Finance Outlook: January 2011
Economic Outlook 2011 (Adobe Flash required). Professor Weigand reviews the current state of the economy, including the components of the Conference Board’s Leading, Coincident and Lagging indicators.